Investing your portfolio: Where are the customers’ yachts?

The wife of a successful entrepreneur once remarked to me that she had pointed out to her husband that there will always be someone else with a bigger yacht in the marina. She was hinting that it’s fine to work, but there’s a point at which you ought to stop and spend a bit of time with your family and friends. She’s since divorced (for him it’s the second time!).

Another boating analogy was shared by The Economist recently in a comment about the asset management industry entitled Living off the people. As an asset manager, investing other people’s money, it was pertinent to my profession. The article offers a synopsis of the fund management industry and the challenges it faces today, the principal one being “Is there any use for fund manager’s at all?” The evidence has been around for decades, and now is being more actively referenced, that paying someone to beat the index is a fool’s game.

You can’t consistently beat the index, and if you have to pay someone to try, that’s going to cost you even more, so don’t even try. Just invest in a low fee index fund, like one offered by Vanguard. The article points out that a quarter of American billionaires work in finance and investment and concludes with a quote from a pre-war Wall Street mogul “Where are all the customers’ yachts?” Instead pay a computer pennies to put yo u on the efficient frontier.

The Economist covered this issue again at the end of March in The Tide Turns suggesting that people were beginning to tire of paying an average of $ 690,000 a year to those picking stocks in the American equity market and moving capital from active managers to low-load index funds managed by the likes of Vanguard and Blackrock. Last year $100 billion flowed out of actively managed funds while $ 400 billion flowed in to index tracking funds. Awareness among investors is being enhanced by regulations requiring greater transparency from managers and requiring them to put customers’ interests first, which of course should be the minimum culture any way. (Yes, I know that’s naive, especially after seeing the fraud at the highest levels that instigated the Global Financial Crisis, but I believe that if we don’t be moral we won’t have morality and that is the essence of trust which is the foundation of money and human relations.)

Technology has pushed fund managers to the edge of extinction, making the business a utility which is effectively funneling cash from investors and pension beneficiaries in to the pockets of fiduciaries. That term “fiduciary” should be used with caution since most of them do not put clients’ interests first. (That’s one of the reasons for my disenchantment with the industry.) Instead practices such as churning compound the statistical fact that you can not achieve a better risk return profile than the market. Today computers, calculating billions of permutations and crunching data in real time can track the market at a fraction of a percentage point each year, so which star investor can beat that? Not one.

So why would you invest in the market in any way other than a low load index fund? Two reasons: For fun, because you enjoy the process and you can afford to accept a sub-optimal risk-return profile. Or because you do not want to invest in certain things, like fossil-fuels, and do want to invest in others, like bio-mimicry or open management. (This is where I operate – investing in unlisted investments which are not accessible via public markets and where value can be added in the selection and management process which a computer can not yet do. In a couple of decades, venture capitalists too will be replaced by androids, but I suppose that’s the fate of all of us unless we choose a different world.)

In both cases you might make money, but you are certainly taking on risk to do so. In some cases, that’s worth it because ethics are more important than profit or making the world better is what you want to do. But the bottom line is that giving your money to a fund manager is not a good investment. Invest in an index fund, or unlisted investments or support philanthropic endeavour (education is one of my favourites).

Once you have appreciated the need to take your pension from a risky, costly active fund manager and reinvest it in a low load, low risk product, and done so, you might reflect on where financial markets are headed. Clearly there has been little clean up since 2008, largely because none of the culprits have seen jail time. More worryingly, stagnation continues to overshadow economies and the recent downgrading of forecasts by the IMF (again) is another harbinger of change. Perhaps the idea of backing private companies or engaging in philanthropy will appeal even more. And if nothing else, remember that it is not money or celebrity that makes people happy, but friendly relationships, so spend some time with family and friends.